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Question

Which of the following correctly explains the standardised approach for computing credit risk under Basel capital requirements, in India?

A Banks to assign risk weights to assets based on internal credit ratings taking into account the probability of default Correct Answer Incorrect Answer
B Banks to assign risk weights to assets based on internal credit ratings taking into account the probability of default and loss given default Correct Answer Incorrect Answer
C Banks to assign risk weights to assets based on internal credit ratings taking into account the probability of default, loss given default and exposure at default Correct Answer Incorrect Answer
D Banks to assign risk weights to assets based on external credit ratings Correct Answer Incorrect Answer
E Banks to assign risk weights to assets based on RBI’s risk based supervision approach Correct Answer Incorrect Answer

Solution

BASEL-III provides two options for measurement of capital charge for credit risk - standardised approach (SA) and Internal rating based approach (IRB). Under the SA, the banks use a risk-weighting schedule for measuring the credit risk of its assets by assigning risk weights based on the rating assigned by the external credit rating agencies. The IRB approach, on the other hand, allows banks to use their own internal ratings of counterparties and exposures, which permit a finer differentiation of risk for various exposures and hence delivers capital requirements that are better aligned to the degree of risks. The IRB approaches are of two types: Foundation IRB and Advanced IRB. In India, banks have been advised to compute capital requirements for credit risk adopting the SA.

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